Future for Egg Derivatives Is Fragile in China

Nov 18, 2013

Future for Egg Derivatives Is Fragile in China

If we were to dream up the perfect commodity to trade as a futures contract, it would probably be durable, non-perishable and subject to regular swings in supply and demand. Being notoriously fragile and perishable, eggs clearly don’t fit the bill on the first two counts, and investors may need some convincing on the third. Eggs aren’t just for breakfast. The Dalian Commodity Exchange on Nov. 8 launched futures contracts, with each lot weighing in at 5,000 tons and each egg weighing 53-60 grams, deliverable to warehouses around China that are cooled to 5° Celsius.But the Dalian Commodity Exchange has moved forward with its plan to launch the exotic derivatives—the Chicago Mercantile ExchangeCME +0.91%

used to carry egg futures but it hasn’t for decades, making China a trendsetter with the new contracts—and after around a week of trade, egg futures haven’t fallen flat, but they haven’t exactly taken off either.

The benchmark May 2014 contract outperformed all other commodity futures on Friday, ending 1.5% higher at 4,013 yuan ($658.53) per 500 kilograms, helped by a rally in China’s stock markets in anticipation of the government’s issuance of a policy document that provided some specifics on economic reforms. Since its debut a week earlier, the contract fell 0.9%.

Despite a moderately successful first week for eggs, some investors aren’t planning to add the futures to their basket of investment instruments.

“I probably won’t do any egg futures because it doesn’t have a seasonality feature that people like me can take advantage of [in] arbitrage trade,” said Jerry Chen, who runs a 10 million-yuan fund with a few of his friends and invests mostly in soyoil, rapeseed oil, and palm oil futures.

Like other agricultural commodities, egg production is cyclical—with supply generally rising in the spring and demand increasing in the summer and fall—but since egg-laying hens are kept in controlled environments, output swings can be modulated better than for crops like soybeans, which are at the mercy of the elements.

But health concerns could wreak havoc with the new contract.

Memories of the discovery of a new strain of avian flu, H7N9, in China in late March, which sparked concerns of a potential epidemic.

“My biggest fear is that one day bird flu breaks out and all the trading will be halted, and that’s the last thing I want to see,” Mr. Chen said, referring to the DCE’s provision for a suspension of all egg-futures trading in the even of a bird-flu outbreak.

Nevertheless, egg producers and large buyers could find the contracts to be useful hedging instruments. The exchange has contracted delivery points with warehouses in 15 Chinese cities.

For traders left holding buy contracts at the time of delivery, the system of warehouses near major population centers provides an alternative logistics option.

The benchmark egg contract generated significant trading interest on its first day, with 264,500 lots changing hands. (Each lot is five tons, which is equivalent to 6,900-7,850 dozen eggs based on the exchange’s specification of each egg weighing 53 to 60 grams.) But daily volume fell sharply every day last week, to just 37,300 lots on Thursday before rising again to 133,500 lots on Friday.

Analysts say the egg futures don’t look very appealing to investors based on the exchange’s 8% margin requirement.

Investors who go through brokerages will have to hold 12% of the value of their positions in egg futures in their accounts, which is “high compared with other futures,” said Gao Bin, an analyst at Shanghai Cifco Futures.

Based on the Friday closing price of the May egg futures contract, the 8% margin means an investor would have to keep at least 3,210 yuan ($527) in his account to trade one lot.

By comparison, the Shanghai Futures Exchange requires a 5% margin, which means a trader going through a brokerage would have to keep 9% in his account, which makes a difference for investors seeking high leverage.

“So that’s why we’re seeing trading volumes are falling each day” since the egg futures contract made their  debut, Ms. Gao said.